Deducting the Cost of Fraud — The Widespread Treatment of Government Settlements as a Mere Business Expense

With its $9 billion take, it has been a record year for the government in terms of its recoveries under the False Claims Act. See Banner Year for Whistleblowers . . . . There was the $3 billion settlement with GlaxoSmithKline over its marketing misdeeds with Paxil and Wellbutrin and its failure to report safety data for Avandia. See Big Pharma Strikes Again . . . . There was the $1.5 billion settlement with Abbott Labs for its misbranding and improper promotion of Depakote. And there was the $950 million settlement with Merck over its illegal marketing of Vioxx. The list goes on and on, particularly in the pharmaceutical industry, collectively dwarfing the previous record set last year of $4 billion in False Claims Act recoveries. See What Is Going On With Big Pharma?Click here for a complete listing by Taxpayers Against Fraud of the top thirty settlements for this past fiscal year.

But according to a recent article in the Washington Post, these settlements may be somewhat less eye-popping than they seem. That is because these malefactors may be writing off a large portion of these settlements as business expenses and saving tens if not hundreds of millions of dollars in deductions on their taxes. The worst part of it all is that as long as the settlement amounts are not specifically defined as a fine or penalty, this practice appears to be totally legal.

Take Bank of America’s Countrywide subsidiary, for example. Last December, it paid $335 million to resolve charges that it had discriminated against black and Hispanic borrowers in its mortgage lending business. The government trumpeted it as the largest residential fair-lending settlement ever. Click here for the DOJ press release. But as the Washington Post reported, the bank could deduct 35 percent of the settlement for a wopping tax savings of $120 million, reducing the bank’s ultimate payout to only $215 million.

A 2005 report from the Government Accountability Office gave some indication as to how widespread this practice may be. Of the 34 government settlements it reviewed, the settling parties in 20 of them deducted some portion or all of their settlement payments. The GAO further found that the DOJ and other agencies negotiating these settlements typically do not address the tax implications of the deal. Instead, they leave it to the IRS to ensure that no foul play is involved. The problem is that the IRS is usually left out of the loop on these settlements.

There have been several legislative attempts to fill in this regulatory black hole. Senators Chuck Grassley (R-Iowa) and Max Baucus (D-Montana) tried to deny deductions for punitive damages with their introduction of the Government Settlement Transparency Act in 2005, an effort that led to the GAO study. This was followed by Senator Bill Nelson’s (D-Florida) call for a Congressional inquiry over BP’s claimed $10 billion tax deduction for cleaning up the Gulf oil spill. Which was followed by the Stop Deducting Damages Act introduced by Representative Peter Welch (D-Vermont), also in response to the BP effort to get taxpayers to share in the company’s ultimate cleanup bill.

So far, none of these efforts have succeeded. What this means is that when these big settlements come down for this ever widening parade of corporate malfeasance, it is not the companies that are ultimately on the hook for the entire amount of the payment. Rather, a large share of the payout is actually being covered by the U.S. taxpayer. This is the very constituency these settlements are supposed to reimburse. Talk about irony.

This is certainly a predicament that needs to be addressed. If not by Congress, then at least by the DOJ by insisting in its settlement agreements that no deductions be taken for any settlement amounts paid. It is within the agency’s power and something it has apparently done on occasion. Otherwise, if this perverse state of affairs continues, these hefty settlements will continue to be treated, as so many companies do, as nothing but a cost of doing business. There is not much of a deterrent effect in that.

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